Farmers & Merchants Bancorp, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Unaudited consolidated financial statements; amounts below are in U.S. dollars. The company is a community bank operating in northwest Ohio and northeast Indiana.
Business context and material changes
On January 1, 2019, the company acquired Limberlost Bancshares, parent of Bank of Geneva, for approximately $78.9 million ($70.4 million in stock and $8.5 million in cash). The acquisition added six Indiana offices and is included in results from the acquisition date. It materially increased reported assets, loans, deposits, and share count, so year-over-year comparisons reflect both acquired operations and organic changes.
Financial results and condition
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Interest income | $17.0 million | $11.8 million | $51.2 million | $34.4 million |
| Net interest income, before provision | $12.9 million | $10.0 million | $40.2 million | $29.7 million |
| Provision for loan losses | $247,000 | $47,000 | $410,000 | $219,000 |
| Noninterest income | $3.2 million | $2.7 million | $8.8 million | $8.1 million |
| Noninterest expense | $10.6 million | $8.1 million | $31.8 million | $23.4 million |
| Net income | $4.3 million | $3.9 million | $13.7 million | $11.8 million |
| Diluted earnings per share | $0.38 | $0.42 | $1.23 | $1.27 |
| Net interest margin | 3.60% | 3.85% | 3.97% | 3.80% |
- Q3 net income rose about 10%, but diluted EPS fell, reflecting the larger share count following the stock-funded acquisition. Nine-month net income rose about 16%.
- At September 30, 2019, total assets were $1.575 billion, net loans $1.152 billion, deposits $1.278 billion, and stockholders’ equity $227.4 million. Compared with year-end 2018, assets rose 41.1%, net loans increased $312.3 million, and deposits increased $349.2 million.
- Cash and cash equivalents were $114.6 million, up from $38.4 million at year-end. Nine-month operating cash flow was $20.0 million; investing cash outflow was $55.5 million and financing cash inflow was $111.7 million, producing a $76.2 million net increase in cash.
- Year-to-date net interest margin improved 17 basis points year over year, while Q3 margin declined 25 basis points. Management attributed pressure to deposit funding costs rising faster than asset yields; Q3 interest expense increased $2.3 million year over year.
- Borrowings at quarter-end included $24.7 million of FHLB advances and $30.1 million of repurchase agreements. Management reported $17.3 million of additional FHLB capacity based on current collateral, up to $97 million with adequate collateral, and $123.4 million of unsecured correspondent-bank capacity.
- The Bank reported a 10.21% Tier 1 leverage ratio, 12.45% Tier 1 risk-based capital ratio, and 13.04% total risk-based capital ratio; management said the Bank and company were well capitalized.
Management commentary, outlook, and risks
- Management described Q3 as a “quarter on fire,” citing acquisition integration, loan growth, and improved mortgage activity. It said core operating profitability was on track with 2019 expectations, described the company as positioned for positive 2019 results, and emphasized growth, new offices, customer acquisition and retention, efficiency, and digital strategy. No quantified full-year earnings guidance was provided.
- Management expects deposit competition to continue pressuring margins. It also identified labor shortages affecting commercial customers and noted agricultural exposure to commodity prices, tariffs, weather, and non-planted acreage, while describing the overall agricultural sector as healthy.
- Asset-quality indicators worsened from the prior-year comparison: nonaccrual loans were $3.275 million versus $483,000 at September 30, 2018; loans 30 or more days past due were $2.496 million versus approximately $777,000. The allowance for loan losses was $6.759 million, and total allowance for credit losses, including unfunded commitments, was $7.189 million. Management said it continued monitoring credit quality.
- A $1.985 million fair-value adjustment reversal associated with payoff of two acquired purchased credit-impaired loans was recognized in loan interest income year to date, materially benefiting reported loan yield. The company also recorded $1.27 million of acquisition-related costs in the first nine months. Excluding acquisition costs after tax, management presented non-GAAP net income of $14.7 million versus $11.9 million a year earlier.
- Interest-rate sensitivity analysis indicated projected margin expansion in rising-rate scenarios and compression in falling-rate scenarios. Management cautioned that actual outcomes may differ from modeled results. Other stated risks include economic conditions, deposit flows, competition, regulation, and loan and investment portfolio quality.
- The company said there were no material changes to previously disclosed risk factors and no legal proceedings. It adopted lease accounting in 2019 with no significant impact; it did not plan to adopt the new expected-credit-loss standard in 2020 and was evaluating timing, with adoption available as late as 2023 under the stated smaller-reporting-company delay.
Important facts for investors to verify
- How much of loan, deposit, and earnings growth is attributable to Limberlost versus organic growth, and whether anticipated integration savings and synergies are realized.
- Whether the $1.985 million acquired-loan payoff benefit is nonrecurring and how underlying loan yields and margins perform without it.
- Trends in deposit pricing, funding costs, and net interest margin, particularly given the Q3 margin decline and management’s warning about competition.
- Developments in nonaccrual, past-due, restructured, and agricultural loans, and whether the allowance remains adequate as the portfolio expands.
- The impact of acquisition expenses, acquired goodwill and intangible amortization, and increased shares outstanding on future reported earnings and EPS.